Investor's Corner: Breaking Down The High, Tight Flag

Any time a stock soars and then holds most of its gains, think of it as a bullish sign.

There's a tendency for stocks to come back to Earth after a big, rapid advance. But those that can stick around their highs demonstrate unusually strong demand.

Keep that concept in mind when looking for the high, tight flag. It's an unusual base pattern, seldom seen even in the course of an entire bull market.

But it has a good track record as a set-up for even greater gains. For some big market winners, it's not unusual for shares to double or more from a high, tight flag. On weekly charts, they sometimes show up as just a middle step in a huge advance.

High, tight flags consist of a flagpole, so to speak, in which the stock surges 100% or more in about four to eight weeks.

Shares then consolidate for as many as five weeks, dropping no more than 20% to 25% from the prior high. This rectangular behavior creates the "flag" portion of the pattern.

The buy point is the highest price in the pattern plus 10 cents.

As in any other type of base, look for a breakout past the buy point in volume at least 40% above the stock's average.

The most recent example of a high, tight flag was on the chart of Tesla Motors (TSLA).

Last year, the stock broke out of a long consolidation on April 1 and nearly tripled in nine weeks. It more than doubled to a high of 114.90 in just four weeks 1, creating the flagpole.

The maker of luxury electric-powered cars consolidated for four weeks and broke out to new highs on July 1.

The conventional buy point was 115. But, as IBD noted at the time, an early entry existed at 107.23, using a short-term peak in the flag of the base.

Volume was mediocre as Tesla broke out, which initially raised questions about the move. But volume started picking up in the days that followed.

Shareholders got a fright on July 16, when a Goldman Sachs analyst cut his price target on the stock, citing skepticism about the company's sales growth outlook.

At the lowest point of that sell-off 2, Tesla was more than 8% below the 115 buy point — a sell signal. But from the 107.23 entry there was no such trouble.

In fact, Tesla found support at the 10-week moving average and continued its ascent.

The stock — one of the big winners of 2013 — rumbled as much as 81% from the early buy point until it started a new correction in October 2013. Tesla formed a 19-week base from which it recently broke out.

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07/27/2015 01:58 PM ET

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